Domestic Firms and the Design of Bilateral Investment Treaties

• In Event: Local Effects of Trade and Foreign Investment Entry

Abstract

Governments and multinational corporations (MNCs) in capital-exporting home countries see bilateral investment treaties (BITs) as a safety net to protect property rights while capital-hosting developing governments consider BITs as credible commitments to property right protection in order to attract foreign capital. Despite extensive research on BITs, the role of domestic firms in host countries is missing by assuming that those firms would welcome BITs in the expectations of technology transfers and improvements in corporate governance. However, signing BITs may hurt domestic firms in capital-hosting developing countries as MNEs empowered by BITs would have competitive advantage over domestic firm, partly leading to a loss of competitiveness and bankruptcy for domestic firms. Relaxing the assumption that domestic firms in host countries have monolithic preferences over BITs, we investigate how heterogenous domestic firms affect BITs. We contend that the impact of domestic firms on BIT design varies by the regime type of host countries. In autocracies, domestic business elites are likely to prefer BITs with stricter investment protective provisions so as to weaken foreign firms’ incentive to push for domestic property rights protection and lead to a stagnating domestic property rights regime. It thus contributes to stymie small and medium enterprises (SMEs), making domestic firms to welcome BITs. And domestic business elites can also protect themselves from being breached by their own governments by forming financial relationships with BIT-protective foreign firms. In contrast, domestic firms in democracies have different preferences over BITs: they tend to lobby to discourage MNCs from entering into host countries (e.g., through higher regulations on foreign direct investment) and demand more compensation for their potential loss due to the competitions arising from the growing MNCs’ entry. In turn, democratic host governments that allow for the expressions of different voices are likely to incorporate the broad interests of those domestic firms and support the inclusion of weaker provisions with greater flexibility in BITs. We test our arguments using a dataset on the power and preferences of domestic firms in host countries and BIT design containing 2479 BITs signed by 183 country pairs between 1959 and 2016. We find strong evidence for our claims. Our results are robust to the inclusion of a large number of control variables, exclusion of outliers, and different model specifications. This paper contributes to the research agenda on the political economy of BITs and the global investment regime in general.

Authors

• Mi Jeong Shin, Shanghai University of Finance and Economics

• Fangjin Ye, Shanghai University of Finance and Economics